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September 7, 2007

A Brave Nanotech World

Nanotechnology sounds like science fiction... but it's becoming a reality.

This broadly defined emerging technology essentially relates to the control of matter on a molecular level where the rules of quantum physics reign. Increasingly, scientists and researchers are creating and using devices and materials that are too small to even be seen by high-powered microscopes--consider that one nanometer represents one one-billionth of a meter. One sheet of paper is about 100,000 nanometers thick, and a human hair is 80,000 nanometers wide.

Supporters of nanotechnology believe that the successful manufacture and application of products developed at such an incomprehensibly minuscule scale will have a dramatic and revolutionary impact on virtually every industry--with particular significance in healthcare, information technology, manufacturing, materials science, and energy. On the other hand, skeptics complain that nanotechnology is a costly pipe dream that promises exciting new products, but will actually deliver very little.

Jack Uldrich, president of NanoVeritas Group, a technology consultancy, cautions that investors should not view nanotech as an "industry"--rather it's more like an omnipotent technology like the internet or electricity, which may provide substantial benefits to all other industries. This is one reason why it's so hard for investors to get a grip on the true value and implications of nanotechnology. Nonetheless, Uldrich expects global corporations spending about $11-billion on nanotech research and development in 2007, up from about $10-billion last year.

Peter Hebert, co-founder and chief executive officer of Lux Research Inc., a research and advisory firm that specializes in emerging technologies, says he has witnessed an "increasing adoption by large corporations of nanotechnology, which is driving product sales and innovations across their business lines." Hebert estimates that revenues from uniquely nano-enabled products will rise to about $2.6 trillion by 2014 (representing 15% of total global manufacturing output) from just $13 billion in 2004.

While some are skeptical of these projections, Uldrich thinks they are valid, citing Wilbur Ross, the billionaire financier who acquired Nano-Tex, which is developing innovative nano-particles in textiles, to make them stain-resistant. "Ross said nano-enhanced textiles will generate $11 billion in sales this year," he notes. "But this figure is expected to balloon to $120 billion by 2012. Similarly, according to another consultancy group, nanoparticle-based drug delivery devices is currently only a $3.9 billion industry. But by 2012, this is expected to increase to $26 billion, then skyrocket to $220 billion by 2015. And there are many similar examples of nanotech companies forecasting exponential growth. Add all these individual companies together, and nanotech could indeed represent a multi-trillion business."

Hebert adds that many foreign countries, particularly emerging economies like China and Brazil, are committed to nanotech research. "They have to leapfrog into new technologies if they wish to sustain competitive advantages," he says. "They've recognized that nanotech is the 'next frontier' and they want to be ahead of the pack rather than play catch-up."

Hebert cautions that while nanotechnology has extraordinary potential, as an investment vehicle, the field is littered with high risk--because nanotechnology is still in its early stages, many of the best companies remain venture-backed, limiting access to few investors. Lux estimates that of the more than 1,200 nanotechnology "pure-plays," that is, companies which rely solely upon nanotech-enabled products, fewer than 5% are publicly traded.

So, how can investors get in on this bewildering new theme? Investing in individual nanotech stocks would be far too risky for most investors, given the field's relatively new and unproven status.

The Lux index consists of companies that make tools used to develop nanotechnology, plus well-established large-cap firms which are using nanotechnology in their existing product lines. For example, General Electric (GE) is heavily invested in carbon nano-tube research; while and IBM (IBM) and Intel (INTC) have made improvements in semiconductors through the use of a new thermal insulating nanomaterial that will result in a 20% drop in power consumption. BASF (BF), the German chemical giant, spent $220 million to establish a nanotech research facility in Singapore--by 2011, this site is expected to generate revenues of $60-billion and $70 billion in new products.

Launched in October 2005, PXN has amassed about $144 million in assets. As of June 30, 2007, the ETF had more than half of its assets (55.7%) in small-cap stocks, quite understandable given that most nanotech companies are small in size. (The ETF is still too new to have received an S&P star ranking).

For the one-year period through Aug. 17, 2007, PXN slipped 1.6%, versus a 15.8% gain for Nasdaq.

Some critics have complain that PXN does not accurately reflect the nanotech sector due to the presence of such large companies like GE, IBM and INTC. While these firms have committed heavily to nanotech research & development, a very small portion of their overall sales relate directly to nanotech. For example, BASF said it recorded about $1.5 billion in sales in 2006 tied directly to its nanotech operations-- but this represents only 2% of its overall revenues.

Srikant Dash, index strategist at Standard & Poor's, cautions that "very specialized industry ETFs are best left in the hands of professional investors who can not only analyze the trends in the specialized industry, but can also study underlying holdings to judge how accurately an ETF is mirroring the industry. Most retail investors should follow the mantra 'don't buy it if you don't understand it.'"

"We took some heat for launching this ETF," says Bruce Bond, president of PowerShares Capital Management. "But we saw a need from investors who wanted to gain access to specific targeted areas of the market, like nanotechnology, that they might not be fully educated about."

Analyses from Lux suggests that the initial market cap size of a "pure play" nanotech company is a good predictor of its future success. Nano-cap companies (market cap below $50-million) offer promising potential; micro-caps (between $50-million and $300-million) are very risky; and small-caps (above $300-million) are reasonably safe investments. Lux cites spintronics sensor manufacturer NVE Corp. (NVEC) and nano-encapsulation equipment maker MFIC Corp. as two of the most promising nano-caps, noting their growing revenues and solid customer bases. Only 16% of micro-caps will survive, Lux suggests, while 32% will vanish and the other 52% will face uncertainties. However, two of the most exciting nanotech firms--Flamel Technologies (FLML) and NanoViricides Inc.--were initially micro-caps.

Small-cap nanotech firms, which are typically financially sound with established history of revenue and earnings growth, will have a 57% success rate; with 43% facing unsure futures. Drug reformulation specialists Elan Corp. (ELN) and Abraxis Bioscience (ABBI)--each of which boasts valuable portfolio of generic drugs -- are among the most glittering in the field.

Uldrich warns that nanotech has been pumped up by so much hype from its advocates, that any bad news in the sector--like a failed IPO or any data that suggests nano-materials could harm people or the environment--may do considerable damage to investor sentiment. For example, in 2004, nanotech was hurt by the withdrawn IPO of Nanosys, a developer of inorganic semiconductor nanocrystal technology.

Recently, the failure of certain catalyst products of Oxonica, one of the UK's most celebrated nanotech firms, darkened investor sentiment. Contrarily, any good news, like a breakthrough new cancer drug enabled by nanotech, or an innovation in solar energy cells, could push nano-stocks into the stratosphere.

As an illustration of both nanotech's potential and pitfalls, Uldrich cites Insert Therapeutics, a subsidiary of Arrowhead Research (ARWR), which is developing an innovative new nanotech-based platform for cancer treatment. "The drug is currently in phase 1 of FDA trials, which means it faces a long regulatory process and may never receive final approval," he says. "More than 90% of drugs undergoing Phase 1 fail to get approval. However, Insert's platform is extremely compelling because the particles it uses are so tiny (just 40 nanometers in diameter), it makes them big enough to prevent being screened out by the kidneys, but small enough to enter individual tumors. Since the drugs would be delivered to their target with pinpoint precision, they'll be much more effective."